Friday, 31 August 2007

For some people the DIY approach to planning personal financial matters may not work, whether due to a lack of time, interest or knowledge. Many of my friends and family would rather do something else with their time than read up on tax laws, figure out investment alternatives or construct spreadsheet calculations to figure out if they will have enough to retire and not be sleeping under the bridge at age 75. That, I have to admit, is the reality, even when substantial improvements can be effected with the simplest actions - witness the large percentage of people who don't contribute to their RRSP ever year.

On top of that, it seems that the challenges of effective personal planning are growing. Financial instruments are getting more numerous and complicated while governments are always adding benefit programs and laws (funny how they rarely seem to be eliminated). Convenient and simple defined benefit pension plans are in decline and people are forced to provide on their own for their financial retirement future. In short there is a case and a place for professional help in personal financial planning.

So, for those people, I've taken a look at the professional financial planning situation in Canada (and will do so for the UK in a separate post; there are some interesting contrasts). I was hoping it would be a quick look, but unfortunately, there is a plethora of more or less overlapping and confusing titles and designations. Advocis, the financial planners of Canada's association, has an abbreviated list on its website. Here's an even longer list that includes US designations. Some of the titles are downright hilarious for their bombast and pomposity, e.g. the Chartered Professional Strategic Wealth or their careful political correctness e.g. Elder Planning Counselor. It is quite possible I have not uncovered all the possibilities despite several days of searching on the Internet! A good article from the Ontario Medical Association reviews the function of a planner and some of the alternatives out there.

The people with formal designations does not even cover the field since there is no regulation of financial planners in Canada, apart from the province of Québec (see L'Autoritédes marchers financiers for their rules about what is required of a financial planner), to restrict those who can call themselves financial planners. Canadians shouldn't feel too bad since there is apparently no regulation of planners in the USA either. Note that such regulation in Canada would happen province by province due to the idiotic and laughable lack of a national financial and securities regulator. There is, however, across-the-country regulation of the provision of advice with respect to investment in securities. For instance, the Ontario Securities Commission regulates anyone who is what they term an Investment Counsel ''... in the business of advising others as to the investing in or the buying and selling of specific securities ... on the basis of the particular objectives of each client'' or a Securities Adviser '' ...in the business of advising others either through direct advice or through publications or writings, as to the investing in or the buying or selling of specific securities, not purporting to be tailored to the needs of specific clients.'' (see this page for details) Such people must register with the OSC, pass formal specific educational courses like the Canadian Investment Manager, the Chartered Financial Analyst and go through several years of supervised work experience. The Ontario Securities Commission has a database of people registered to work (in Ontario only) along with the type of services they are authorized to provide. The National Registration Database has a contact list of all the provincial and territorial securities regulators through which one can find out who is authorized to provide similar services in the other provinces.

The Canadian Securities Administrators website has a handy guide that explains what is and is not regulated in Canada. The guide also explains the difference between advisers in investments, sales people for mutual funds or insurance and financial planners. The essence of a financial planner is the ability to incorporate all aspects of a person's financial situation - income, budgets, investments, taxes, mortgage, investments, insurance, trusts, pension, retirement - into a coherent, balanced integrated plan that supports the person's life goals. The planner is somewhat akin to the general practitioner / family doctor. Some simple or common situations are treated directly, but it may be necessary to call upon specialists.

Financial planners have been trying to raise their occupation into a profession like that of accountants and lawyers. That's the stated aim of Advocis and the Financial Planning Standards Council (FPSC). To do this, they are setting requirements for education, experience and ethics, which seems to me to be a good thing, though I think there is some improvement to be made in the actual requirements as they exist today. This recent article in Investment Executive reviews the current status of the professionalization efforts.

The Certified Financial Planner title granted by the FPSC appears to be the designation with the most adherents in Canada (almost 17,000 according to the FPSC). As an apparent tactic to gather all planners into its fold, the FPSC accepts a multitude of training courses and other designations as adequate proof of meeting the educational requirement. However, everyone must still write the FPSC'sCFP exam. That's a good step, I believe since it ensures everyone has the same knowledge base. The problem may be the depth of knowledge. If one starts from scratch with the Advocis course, there is perhaps 300 hours of study to pass all the courses. That's not much compared to what professionals like doctors and lawyers have to do. The fact that most of the education programs for the CFP are offered by community colleges attests to the fact that the assumed level of knowledge is not university degree level. When I look at the curriculum covered for investing ''Module 1: Time Value of Money Fundamentals'', '' Module 16: Investments - Products'' and ''Module 17: Investment Planning'', it looks pretty basic. I doubt very much it covers even a fraction of the content of the standard university level text on the subject, Investments, the 900 page tome (5th Canadian edition) by Bodie, Kane, Marcus, Perrakis and Ryan.

I can understand the challenge of the FPSC and Advocis in not reaching too high on the educational ladder, as such insistence would cause a revolt among practising planners who would have to go back to school in a major way. There's also the fact that planners can do a whole lot of good for people applying those basic techniques and strategies. I've certainly noticed that amongst my friends and relatives. The on-going requirement of 30 hours professional development per year that FPSC requires to maintain the CFP helps raise the level of knowledge somewhat.

Truth be told, other designations look quite similar in their educational requirements, so the above comments don't mean CFP is deficient. In fact, the CFP seems to be better in protecting the designation by policing its members and disciplining transgressors as seen on the front page of the FPSC website. I could not find any such indication of policing on the Institute of Canadian Bankers website, which hosts the competing designation, the Personal Financial Planner. Nor is there any mention of continuing education obligations to keep the PFP. The same goes for the Financial Management Advisor of the Canadian Securities Institute.

The CFP is the best of the lot but it has another element where it could use improvement. That relates to the disclosure of fees. A CFP is not necessarily a fee-only adviser, which is the most impartial type in my view - you pay only for the advice, no commissions or fees paid by mutual fund companies. In other words the adviser is totally on your side and has no incentive to have you buy anything, if that isn't good for your financial health (I'm thinking especially of insurance and mutual funds). I don't know what proportion of advisers in Canada are fee-only but it must be a small minority (see this discussion on the Financial Webring regarding the challenges of being a fee-only adviser) since the fact that the client does not actually see the commissions being paid in the background creates a psychological preference for that type of arrangement. All this to say this - although the ethics policy of the FPSC requires that the CFP disclose on what basis the adviser is being paid under rule 401, it does not, but should, require disclosure of the amount of the commissions and fees paid to the adviser by the companies. It is interesting that the consumer advice section of Advocis in its recommendations of questions to ask a potential adviser before signing up, says you should ask ''Can you give me a dollar estimate of what those fees and costs would be for someone with my needs?'' Why not require that disclosure of a CFP then?

Overall, the CFP seems a reasonable place to start. Advocis provides a search tool to locate an adviser, oops, advisor (why can't they even agree on a spelling!?). However, the key is to find someone on your wavelength and whom you can trust.

Tuesday, 21 August 2007

A friend recently asked me what would happen with an inheritance that he expected to receive sometime down the road from a relative in the UK. Since it might be of interest to others out there, here is some information that may help you get started.

For inheritances, whether from Canada or from the UK, there wouldn't be any tax to pay on the lump sum received. However, once in your hands, you would be liable to taxes on any interest, dividends or capital gains the invested money might generate. That would be the case whether you physically repatriated the money to Canada or invested it in the UK. People considered residents of Canada for tax purposes are liable to pay income tax on their worldwide income.

Any UK inheritance would first be taxed according to UK laws, notably the inheritance tax, which kicks in above a tax-exempt 300,000 (in 2007-08) pounds sterling amount at a rate of 40%. Afterwards, once in your hands, if left/invested in the UK, there would be UK taxes on whatever income was earned. The UK taxes would count as a credit on your Canadian tax return so you wouldn't get taxed twice.

An interesting potential alternative is for your relative to put in his/her will to create a trust in a low/no tax place like the Isle of Man or the Bahamas. This is called an Inbound Inheritance Trust, which would hold the funds instead of you. The money could then grow on a tax-free basis, much like it does in an RRSP. Any payment to you of the original capital would be tax-free, while you would pay Canadian income tax on withdrawals of any income or gains. An added advantage is that disposal of the trust would not be subject to probate fees ($5 per thousand on the first $50,000 and $15 per thousand on the excess in Ontario). Below are a couple of links to articles that describe the Inbound Trust. Note the comment in the first article that this is a practical strategy for a substantial inheritance of $500k or more and that was back in 2002. Much as I am in favour of do-it-yourself, the complexities of such a vehicle would have me speaking to a lawyer and accountant specialized in such matters in order to get it right and not have it invalidated by the Canada Revenue Agency.

Monday, 20 August 2007

I've just finished helping a family member buy a car here in Scotland. The experience has been uncannily similar to that which occurs in Canada, a disagreeable negotiating process in which one feels taken advantage of, no matter how much of a price reduction one manages to negotiate. The less one likes cars, the better one is likely to do in negotiations since the dealers prey on our emotions - liking a particular car - to extract the most from us. There are a couple of things that arose in the buying process which I found especially dangerous to the consumer and which may save others lots of money. In our case, buying a car of around £8000, it made a difference of £650 in financing costs.

Tip - Get Prepared before Going Shopping
Duh? Perhaps this is too obvious to say, but doing a few hours research before leaving the house will save you money, will give you a car that satisfies your needs and should make the whole business much less stressful. That means figuring out things like:

a target price to pay, both in total and on a monthly repayment schedule

which cars fit into your price range, the comparative pros and cons of those cars - buy What Car? magazine.

It also means reading up on the car dealers' sales tactics and how to counter with some of your own - e.g. how to do the good guy/bad guy routine to the dealer. Doing this stuff can actually start to turn the whole anxiety-ridden negotiation process into a kind of fun game, once you begin to feel on even terms with the dealer. Check out Car Buying Guide for some advice in that regard.

The above websites have a lot more detail and cover other important car-buying topics that really helped us.

Trick - Beware of Flat Rate Interest Calculations
Caution!! When we asked for financing rates at the dealer, the salesman initially offered us 6.0%. This sounded quite good, especially since bank loan rates currently start around 6.3%. This happened at all of the dealers we visited. One offered 5.25% and that sounded wonderful ... until we came home, did a little research at the above websites and discovered that UK car dealers will quote a so-called ''Flat'' interest rate on the loan that sounds reasonable but is actually about half the rate really being charged. In fact, car dealers are obliged by law, as regulated by the Financial Services Authority to tell the car buyer the real interest rate being charged, called the Annual Percentage Rate (APR). If we had gone through with a loan from the dealer we would have found out the APR but during discussions with the salesman, he was unwilling to tell us the APR. Note that APR is simply a normal amortized loan formula, whereby the interest is charged only on the declining principal balance as each month's payments reduces the principal over the term of the loan. APR is the only way to properly compare the cost of loans of differing terms and amounts. The same Flat Rate, on the other hand, will have a slightly different APR depending on the term or the amount (see my little comparison table image for an illustration of this).

This page of the Car Buying Guide shows step by step how the Flat Rate is calculated. It turns out that the Flat Rate charges interest on the total initial amount of the loan for every month of the term. If you borrow £8000 at 5% for 3 years then you get charged interest of 0.05 x £8000 = £300 / 12 months = £25/mo. each and every month for 3 years. A good graphical illustration and explanation of what is happening can be found here at MoneySavingExpert.com. What an unfair and deceptive way to charge interest!

Car dealers live in the real world too and they make more or less money on the basis of APR - more if the APR on the loan to the buyer is higher, less if it is lower. But their financing profit on a loan that is close to double the going best loan rates is perhaps more than the profit on the mark up of the car itself. So maybe they don't care about the fact that they make a slightly lower rate of profit (as measured by APR) on a five-year loan than on a three year loan.

Maybe they don't care but I think the real reason is that few car dealer sales people probably realize what they are doing and how the rates work out. Apart from the devious way it presents a seemingly lower rate of interest, the main characteristic of the Flat Rate method is its simplicity in terms of doing the calculation. No more than a calculator with big buttons and arithmetic functions is required, a definite plus when it comes to training sales people who may not even have finished secondary school (at one dealer we visited, the trainee salesman was a bricklayer who had decided to change occupations). By contrast the proper APR method requires calculating discounted cash flow (see the Wikipedia entry for the amortization calculator ). Ask yourself whether the average car sales person you have encountered could work out an APR payment. In fact, even the Flat Rate method seems to challenge some car dealership personnel as we were told by one sales manager a monthly payment amount for a supposed 5.75% Flat Rate that came out at 19.5% APR, which is not possible if done right. By the way, this reinforces the advice on those car advice websites cited above that one should always check the dealer's calculations for errors. Probably the sharp car dealership owner who invented the Flat Rate method realized that the combination of calculation simplicity and subtle consumer deception makes for a really useful sales tool.

In retrospect, we should have been suspicious of being offered financing on the spot without any credit check whatsoever by the dealer. The high Flat Rates likely more than offset the dealers' costs of bad loans to poor credit risks and give them the leeway to use this sales tool willy-nilly.

Tip - The Bank Won't Give You Its Best Deal Unless You Ask
Once we had figured out what was going with Flat Rate financing and that the rates at dealers were much too high, we visited our local bank branch of a major UK bank, where the car-buying family member has had an account for years. In other words, she has been a loyal customer with a stable job and a high credit rating.

So what was the initial offer - this time quoted in APR terms, hooray! - from the bank when we enquired? Answer: a measly 9.9%! Then we asked why we should not borrow from one of the on-line offers of other major banks on the MoneySupermarket website, whose range started at 6.3% and where the majority seemed to be around 6.9%. We left the bank and the manager promised to ''see what he could do''. Within a few hours he called back saying that lo and behold, the bank would now match the 6.9% rate because she was such a good customer and such a good credit risk. As they say, ''get me a bucket, I'm gonna be sick''.

After declining the bank's solicitation to also take out repayment insurance in case of accident or job loss - i.e. to pay more so that the bank could be sure of receiving the money, it was a done deal. The attached chart shows the net saving of £652 in total interest costs during the 3.5 year term of the loan over the dealer's initial financing offer, £470 over the bank initial offer and £442 over the dealer's best offer. That's a lot more than the £250 we managed to obtain as a reduction on the actual price of the car.

Wednesday, 15 August 2007

In the months since May when I implemented a complete overhaul of my investment portfolio and adopted an asset allocation approach (for the details see my May 23 post), I have noticed a curious and welcome side effect - much less worrying about the direction of the stock market. Even as we have been lately experiencing a severe drop in markets, I do not find myself anxiously checking the state of the markets or my portfolio's value. Why not? It's because my new approach includes explicit rules about when and how much to sell or buy what types of equities or fixed income. Those rules say I will re-balance next May and re-establish the percentages of my target allocation to the various asset classes. I believe that I have set up a good plan that will produce excellent results through both market ups and market downs. This confidence, I am pleased to discover, greatly helps to sustain my patience to wait out the more disappointing market results.

I can remember the feelings of panic and helplessness in the huge slide of 2000 - 2002 when I did not have any strategy beyond what might be charitably called a vague intent to ''buy low - sell high'' (which turned out as often as not to be the reverse). Truth be told, vestiges of the random bargain-hunting thought process have manifested themselves lately when reading the prices of the banks like the Royal Bank and the Bank of Nova Scotia, which look cheap and are tempting to buy. But I am suppressing those successfully (so far, at least!) with reminders to myself that they don't fit into the plan.

Authors like Benjamin Graham, Richard Deaves, Richard Ferri and others caution that an investor's own erratic and emotion-driven behaviour is the investor's worst enemy. I am finding that having a clear and specific investment plan is helping me avoid doing anything rash like panic selling and is helping me feel calmer and in control. (Of course it always possible that we are in a financial Titanic having hit a seemingly innocuous debt iceberg, but I will at least look dignified going down with the ship.)

In short, here are the investing principles I am now trying to follow:

create a specific plan, i.e. one with numbers; writing it down also helps

make sure the plan is reasonable, e.g. explain it to your wife/husband, father, mother, uncle, best friend, co-worker, financial advisor and see if they are nodding in agreement and understanding or have puzzled and disbelieving looks on their faces afterwards

follow it; if necessary, enlist someone's moral support; if the plan doesn't seem right, go back to the first two steps

I know I feel less queasy right now for having such a plan as the markets take a hammering.

Saturday, 4 August 2007

The title does this book an injustice - it should be something like "What Kind of Investor Should You Be?" Though there is ample descriptive content within its covers, the fundamental aim is prescriptive - giving guidance on how to approach investing. The subtitle - A guide to finding the investment solution that is right for you - more aptly describes the book.

Author Richard Deaves is a finance professor at McMaster University and he uses his background and training to incorporate the results of the vast academic research in finance. The value and the achievement of this book is his ability to select and simplify that content into a compact handbook. Investing can easily be dauntingly complex and this book will be especially useful to the newcomer who needs to know where to start. In fact, I've passed my copy along to my teenage daughter who is just starting to get into investing with her savings. Deaves assumes the reader knows little about investment terminology so he explains all terms he discusses.

The appeal to the more advanced investor comes from excellent references and from additional tidbits and pieces of information. Some of the unique and valuable elements of that nature, to me at least, are:

the Canadian data and perspective

the discussion of the enormous effect of psychology and emotions on investing results

the possibility of picking the mutual fund manager who will be successful in future (as opposed to those who have been successful in the past) and how to implement such a strategy

how investment clubs fare

the fact that half of the actual skill of mutual funds managers comes from stock picking ability and half from style choices (small cap vs large cap and value vs growth); this is interesting because a do-it-yourself investor purchasing Exchange Traded Funds (ETF) can achieve the same benefit from the style factor with little effort.

Another unique feature of the book is an associated on-line self-assessment tool for an investor that aims to evaluate investment knowledge, personality and temperament. I did not try this questionnaire since the copy of the book I have does not contain a password to access it. This is likely because my copy came direct from the publisher for review purposes and was not purchased at retail. Thanks to Mike at Insomniac Press for supplying a copy.

Each chapter has a brief summary page, with useful footnotes and suggested readings for those seeking more detail. Due to the wide scope of topics, there is not extensive treatment of any one area in a book only 244 pages long. But Deaves manages to intelligently summarize the gist of subjects and to weave the whole into a coherent story. He concludes that most people are much better off as passive index investors using ETFs, as opposed to the options of buying actively-managed mutual funds or assembling a portfolio from individual stocks and bonds. As to whether a person should be a do-it-yourselfer or should rely on a professional advisor, Deaves says both are viable but to be effective the DIYer must be willing to gain the knowledge and the discipline to follow a good plan.

In the final chapter (page 225), he presents a simple portfolio of four ETFs that would be a good starting point for anyone:

Note that I have added the ticker symbols since they are not in the text (something I would have wanted to see there). Note also that XSP and XIN are currency hedged, in other words the effect of currency swings relative to the Canadian dollar have been removed by the iShares managers through currency trading. At the time of writing, the XSP and XINiShares funds sold in Canada on the TSX were not currency hedged but they are now (that began in November 2005). EFA and IVV are the unhedged versions available through US markets. Those are the versions that Deaves would likely advocate buying today since he includes currency risk within his assessment of foreign investing and concludes that foreign diversification is worthwhile.

Interesting Quotes

''Using data from 26 international stock exchanges, researchers have shown that when there is more sunshine, stock prices tend to rise.'' (page 86) is that why there isn't a stock exchange here in Scotland as prices would never rise? why doesn't the NYSE move to Arizona?

''... the average Canadian (mutual) fund fell short of its benchmark by roughly 1% per year.'' (98) Take this with another statement by Deaves ''The main positive element is clearly professional money management.'' (57) One might question how it is a benefit to entrust one's money to mutual fund managers if they cannot even meet the market average. From the perspective that the index return can easily be obtained by investors through ETFs (the low costs of the ETF do admittedly cause a slight under-performance relative to the index but still ahead of mutual funds), professional management is not an advantage. However, most individual investors do a very poor job, and get poor investment returns due to under-diversification, over-trading, momentum-chasing, home bias and other mistakes that Deaves details. So, in that sense, mutual funds professional management can be better than bad DIY. Nevertheless, for the rest of us who follow the humble passive indexing strategy, we can expect to do better than most of the professional mutual fund managers.

''Apparently many investors think that their funds are performing better than they actually are.'' (104)

''... educated people are not only more confident than those with lower levels of education ... but they are also more overconfident.'' and ''... it is not just amateurs who are overconfident, but also people in their fields of expertise.'' (115) in other words, beware of the professionals and especially of yourself!

''... despite its fame, the Dow is a weak index.'' (131) could we call it the Paris Hilton of stock indexes?

Two Caveats

There are two areas where I find the book lacking and disagree with its conclusions. The first is the use, or not, of real estate investments, in the form of REITs or a REIT ETF within even the simplest portfolio. Deaves does not think it worthwhile or necessary to own a real estate security. But the very basis for diversifying internationally - the non- or negative-correlation of such holdings with Canadian equities, or other equities for that matter - is even stronger with real estate. It would thus be even more beneficial to include real estate in a portfolio than US or foreign stocks. The second point of disagreement is Deaves' acceptance of the principle that people should reduce their equity exposure as they get older. In the last chapter, the sample portfolio further simplifies this to having the same percentage of fixed income in the portfolio as one's age e.g. is you are 50 years old, then you should have about 50% of your total investments in fixed income. Some retired people I know can easily live off their inflation-indexed lifetime pension, in which case their overall investment portfolio essentially already has a more or less perfect very large fixed income component. A much better principle would be to set the investment portfolio asset allocation based on when and how much one needs the money. In the course of the text, Deaves does discuss various factors that suggest exactly that principle but his simplified summary doesn't reflect it.

Overall, however, this is a very useful book, particularly for the beginning investor, but even advanced investors can likely learn a thing or two. Some people who have been investing for years may gain great benefit if they stop being haphazard and adopt the sound principles that Deaves puts forward. Four out of five stars. The book was published in 2006 by Insomniac Press. Buy it from Chapters Indigo.